Sunday, August 16, 2009

Set a Price: How Business Owners Decide How Much to Charge

Startup Sunday

As a new business owner, one of the first decisions you'll make is how much to charge for your products or services.

It's not easy to set a price, and you'll refine your pricing structure as you gain experience. But even before you start your business, you can make some basic judgments to set a price. This week I'll write about how to set a price for services; next week I'll address how much to charge for products.

Step 1 to Set a Price: Total Your Expenses

First, take a hard look at the costs of doing business. That includes any employees' hourly wages and benefits, office space rental and utilities, marketing costs, supplies and, of course, employment taxes. If you're a consultant starting a business out of your home, your bare-bones expenses are what you need to make to cover your living costs -- make sure to remember child care costs.

Once you total up your expenses, you have a minimum figure for the revenue you must generate. If your costs are $3,000 a month, you must make at least that much to keep the lights on.

Step 2 to Set a Price: Value Your Time

The most important input to a new business is the labor of the business owner. That's you! Think realistically about how many hours a week you can devote to your business.

If your children are in grade school, you may be able to work 9 a.m. to 3 p.m. and for an hour or two after they're in bed. That's 35 to 40 hours a week -- as long as you can compress running the household into other times of day or have a spouse who can take on some (or most) of those duties.

At least a third of your time will likely be consumed by marketing, networking and business operations such as invoicing and record keeping. So you really only have 23 hours a week, or 92 hours a month in which to perform income-producing work. The longer you're in business, the better you'll understand how much time you have to generate revenue -- and how much you need to spend on running, maintaining and growing the business.

Taking the example above, you need to charge at least $32.60 an hour, multiplied by 92 hours, to produce $3,000 in revenue to cover your basic monthly costs. That is your price floor -- if you charge less than that your business will lose money.

Step 3 to Set a Price: What Would It Cost In-House?

Many service providers are filling a role that a company could bring in-house, but doesn't want to. So a useful comparison is looking at the cost an employer would pay for an employee completing similar job tasks as yours.

You can use a basic online salary calculator, such as Salary.com, to figure out an equivalent full-time salary for the job you'd be performing. Multiply the annual salary by 2, in order to take into account benefits the employer would have to pay. Then divide by 2080, the number of annual hours for a full-time position.

For instance, suppose I were a graphic designer in my hometown of Washington D.C. Salary.com gives an average salary of $50,600. Multiplying by 2 and dividing by 2080 gives $48.65 an hour -- the cost to the employer of having someone on staff do the job.

That doesn't take into account the hassle of managing a person or the commitment of adding an employee, but it gives another point of comparison. Using our earlier example, you can now think about setting a price between $32.60 and $48.65 an hour.

Step 4 to Set a Price: What Do Competitors Charge?

The final piece of information you'll need is what your competitors charge. You can find out by asking prospective customers what similar service providers cost, in an informational interview.

But I've found the most useful and direct method is to ask competitors what they charge. You can't do this in the first meeting, naturally. But as you network and get to know other service providers in your field in your area, the ones who seem the most receptive to developing relationships are your best resource.

They can tell you which clients pay poorly or slowly. They can refer jobs to you when their business is too busy. And they can give you a sense of whether your pricing is too high or too low for the market. Often, they will be in a slightly different market than you -- aiming for a different kind of client or type of work -- so you will find ways to collaborate rather than competing.

The vast majority of small businesses in America have no employees. That makes it very hard to scale up or down to adjust to changing work flows. So many entrepreneurs rely on relationships with competitors to meet their clients' needs in a busy time, and to pick up extra work during a slow period.

You'll likely return to the question of what to charge for your services over and over again, and every time you'll get better at setting a price that maximizes your profit without turning away customers that you want.

Comments

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